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Let’s Keep The Sprinkler Running

Happy New Year!

2018 is here and with it the new rules to limit income splitting by Canadian small businesses comes into effect.

Bad doctor. You income sprinkler. Very bad doctor.

Our Prime Minister and his Minister of Fairness, who were both born into households with vast wealth that has sprinkled down onto them like fairy dust, want to make sure that those with Canadian Controlled Private Corporations (CCPCs or commonly called professional corporations) don’t try and “sprinkle” such wealth onto their families.

Giving dividends to your non-minor kidults, parents, or spouse will be taxed at the highest marginal tax rate unless they work over 20h/wk in your business on a sustained basis in the past 5 years. You need to be able to prove it with timesheets, schedules, payroll etc.

For a business that is neither a CCPC nor an over 90% service-based business- if the owner works in the business over 20h/wk, then are excluded and they can still give their spouse (who is not contributing to the business in any way) dividends as per usual… Hey, I thought it was about “fairness”! You would almost think it was about politics and that those with CCPCs were easier targets or something.

Those over 65 are able to give their spouses dividends. This modification to the original proposal was made because it was pointed out that salaried employee’s can split their pensions or RRSPs.

How did we get here?

In an effort to make yet another tax increase more palatable (difficult) while trying to continue to portray that they are playing the noble role of Robin Hood, Wild Bill painted this move as a reaction to the unfair situation where high income earners with a CCPC (doctors, dentists, accountants, or lawyers mostly) or other successful small business could pay less tax compared to high income salaried employees. It is true that income splitting within a household reduces the tax bill. Undoubtedly, it is also true that those high income earning professionals have been more aggressive at trying to reduce their tax bills as they have seen their income taxes dramatically rise over the last few years – now up to a punishing 54% top marginal rate.

The government needs money and they don’t like it when you go out of your way to legally decrease your tax bill. So, they change the laws.

The hole in the “We had to do it to be fair argument”.

The other way to improve fairness would be to allow all households to income split. Of course, this would potentially reduce every couple’s tax bill. Definitely not what a spendthrift government would want. In fact, one of the first things axed by the current Federal government was the Family Tax Credit which allowed income splitting within a family of up to $50K/yr. The incoming government argued that it was unfair because it resulted in higher income earners paying proportionally less tax. This is true that someone paying a 48% tax rate would save more tax than someone paying 25%. Duh, it is because they are paying more tax! Of course, they also cut down the TFSA limit, saying only rich people could save enough to use it. As pointed out elsewhere, if your are a middle to low income earner, the TFSA is your best friend. On the other hand, RRSPs benefit rich people because those in the highest income bracket save the most tax. Just like with the Family Tax Credit.

The thing about “fairness” is that what is fair is a subjective judgment where two reasonable people can often disagree on it – hence the politics.

Philosophically, it is hard in my mind to justify why a household with two parents making $80K each should pay less tax than one where one earns $160K and the other parent stays home to fill the vacuum of running the household that someone working a high income job usually leaves in their wake. The government is placing a financial disincentive on the one income family with a stay-at-home-parent compared to the double income family. Further, it would be even harder or prohibitive for a more modest income family to have a stay-at-home-parent.

In my personal situation, my wife would love to go back to her career. We talk about it frequently and are trying to find solutions. She gave up her career as a counselor after our second child. She quickly went back to work both times, but about a year into the second time it was killing our family dynamic. Some specialties in medicine are conducive to both partners working, but mine has really long, erratic, and unsociable hours. I also can’t just leave work if my kid gets sick because of the nature of the work. So, it all has fallen onto her. I know many other professional colleagues, both male and female, whose spouse have had to give up or curtail their career for the same reasons. This isn’t a conundrum unique to medicine. Many families (and therefore society) could benefit from the stability of a parent staying at home, but our individualized rather than family oriented taxation system forces the decision. We feel fortunate to at least have had options due to our personal finances.

Yes, you can hire help such as a nanny and house cleaner etc, but that is also a value and financial judgement. We decided that we wanted to be the central caregivers for our children. My wife also vetoed the cleaner because she would have to “tidy up” before they came to clean and she has “a thing” about someone rifling through our laundry or dresser drawers. She is, however, still looking for us to hire a chef 😉 Even though my spouse is “at home”, she is honestly pretty busy managing the finances and administrative pieces of my practice as well as our household. It adds up to a full time job for sure. Double income families certainly have my respect with being able to work and manage the rest. I just don’t think the government should be dictating financially which way people should go.

Anyway, we live in a democracy where we vote in a government and they set the rules. So, my personal opinion doesn’t really matter. I have only expressed it to give my perspective on why I think that income splitting in a family is actually important and a good thing to do socially. I have no problems with “paying my fair share”.

Since fairness is subjective and varies in the eye of the beholder, what does a broad accounting of Canadian stakeholder opinions reveal about our tax system and income splitting?

Well, this hasn’t been systematically looked at in a long time. In the early 1960s, the Carter Commission took a comprehensive look at our income tax system to advise on Canadian tax reform. It took about 4 years, in contrast to “Wild Bill’s 75 day Consultation Period” on the current changes. In regards to the topic at hand, it suggested the household as the basic taxation unit rather than the individual. In reviewing the current proposed legislation, the Senate suggested not moving forward, but having another more comprehensive tax system review. The T2 government has decided to move ahead anyway and there is more to come with their new rules for passive income for CCPCs in their 2018 budget. Winter is here.

So, what is a person with a CCPC or small business to do now???

The political spin has been that CCPCs and small businesses can income split while normal Canadians cannot. Check under your desk and in your lamps for bugs, frisk your partner for any hidden wires, and close the blinds…

Whew. That sounded like the prelude to “date night”, but actually it is the necessary precautions to take before reading my next series of posts.

There are actually a number of ways that any person in Canada (even those nasty tax loopholin’ rich CCPC owners) can use to “income sprinkle”. Our mission is to learn how to use them and keep the sprinklers running. This message will self-destruct.

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2 comments

Looking forward to hearing how you can still “income sprinkle” with CCPCs. I only know of the “Capital Gains Strip” strategy that some physicians are using to “income sprinkle”, but my group’s tax lawyer feels strongly that this “loophole” will be closed in the near future. It was supposed to be closed in last year’s budget, but the government changed their mind in the end. Only issue with this strategy is that it costs approx. $10k to set-up!

I think your lawyers are right or will soon be proven to be. It was on thin ice for a while. CCPCs were the most convenient and efficient way to split income, but there are a bunch of other ways outside CCPCs themselves that add up when you put them together. I started using a number of them around the time of the 2015 election because the writing was on the wall of where things were going to go. As a result, right now our financial assets are pretty evenly split between my wife and I and she generates good cashflow taxable in her hands without working outside of our business. You can still use dividends to income split from a CCPC if over the age of 65. I plan on being retired well before then, so we needed ways to ensure that we even out our income generation well before then.

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